Uncertainty on Israel's Bill to Exempt Foreigners from Crypto Tax

The status of the Israeli law aiming to provide tax exemptions on the sale of digital currencies to foreigners and to exempt foreigners from Capital Gains taxes on the sale of digital currencies has been surrounded by much uncertainty. This is amidst the immediate demand for government revenue due to the Israeli-Palestinian conflict following the Hamas attack on Israel on October 7, 2003. The bill seeks to position Israel as an attractive investment destination for crypto capital and to foster the growth of the Israeli crypto sector.

Many foreigners believe this exemption bill has become law, whereas others remain skeptical. This confusion is not surprising as Israel already offers similar tax exemptions for foreigners who become Israeli residents. Such favorable tax exemptions are not available in countries like Canada. Many believe Israel generally offers a more favorable tax environment for foreigners.

Did Israel Pass a New Law to Exempt Foreigners from Crypto Tax?

In July 2023, Israeli lawmakers engaged in an early plenary session, where they proposed a bill to offer tax exemption on the sale of digital currencies to non-residents. The bill also proposed an exemption on capital gains taxes for the sale of digital currencies by non-residents. 

The primary aim of this bill is to attract foreign crypto capital into Israel and to expand the Israeli crypto sector. It also proposes favorable taxes for the transfer of digital currencies to employees, including a tax rate reduction on digital currency options for employees from 50% to 25%. The bill, called "Bill to amend the Income Tax Ordinance (tax exemption on the sale of digital currencies to non-residents and in the allocation of digital currencies to employees), Hatshep 'C' 2023" is currently before the Knesset's finance committee (Israel's national legislative body), awaiting preparation for its first reading.

However, amidst the Israeli/Palestinian conflict ("iron swords war") and Israel's urgent need for funds, many question if Israel is willing to forgo immediate crypto tax revenues in favor of future investments through exemptions.

Israel's Current Crypto Tax Regime Concerning Foreign Investors

Israel's proposed bill to exempt foreigners from crypto tax is not surprising since Israel already exempts new residents from taxes. Israel offers such foreigners a 10-year tax exemption on income from assets or businesses held outside Israel, which includes crypto assets. The exemption also extends to interests, dividends, royalties, and capital gains from such assets. The 10-year period begins when the foreigner first becomes a resident of Israel. Similar exemptions apply to returning residents who have lived outside Israel for at least 10 consecutive years.

Besides the above exemptions, Israel currently has a similar tax regime to that of Canada concerning crypto. In Israel, digital currencies are considered "assets" rather than currency. Refer to Article 88 of the Israeli Income Tax Ordinance. The disposition of crypto assets will be included as capital gains or business income depending on the circumstances. If the disposition results in capital gains, a tax rate of 25% is generally levied on the gain. However, if the sale results in business income, the tax could be up to Israel's top marginal tax rate of 50%.

Similarly to Canada, Israel taxes non-residents on their Israeli sources of income and residents on their worldwide income, including taxes on crypto transaction incomes. Because crypto assets are not legal tender in Israel, when a crypto asset is used commercially for purchasing goods and services, it is treated as a barter transaction (an exchange of goods or services), and Value Added Taxes are applicable.

Finally, Israeli residents with foreign assets worth NIS 1,916,000 or more (about $750,000 CAD) must report this to tax authorities, as per regulation 3(a)(6)(b) of the income tax regulations 1988. This includes crypto assets. No exceptions seem to be made regarding the connection of the asset with an active business, as is available in Canada.

 Taxation of Crypto Assets in Canada: Foreigner-affiliated Crypto in View

Canada does not have a similar regime to Israel, which exempts new and returning residents from taxes on their assets and businesses abroad. Therefore, income from digital assets held outside Canada is subject to tax for Canadian new or returning residents. As soon as a person assumes Canadian residency, their worldwide income earned after becoming a Canadian resident becomes subject to tax. Non-residents who earn income from a Canadian source will also be subject to tax on that income.

In Canada, crypto assets are usually classified as commodities for tax purposes. If held as capital property, 50% of their realized gains will be subject to capital gains tax, equivalent to a 25% Israeli tax rate. Amendments intended for retroactive effect from June 25, 2024, will increase Canada's capital gains tax inclusion rate to 66.67%, exempting individuals up to a $250,000 CAD threshold. Graduated Rate Estates and Qualified Disability Trusts are also eligible for this threshold exemption under certain conditions. 

Also, in Canada, if crypto assets are used as part of a business activity, the realized income will be taxed as business income, with a combined federal and provincial tax rate of about 50%, akin to the Israeli rate. Furthermore, crypto assets are not considered legal tender in Canada. When crypto assets are used as currency for purchasing goods or services, these transactions are also treated as barter transactions for tax purposes, similar to Israel. Canadian Goods and Services Tax (GST/HST) will also be applicable.

Finally, crypto assets owned by Canadian residents outside Canada are treated as foreign property. When the total foreign property costs exceed $100,000 CAD, they must be reported. However, foreign property exclusively used in an active business is exempt from this requirement.

Securities Regulation of Crypto in Israel

Regarding securities, Israel has yet to develop a comprehensive regulatory framework for crypto assets. The primary legislation on the subject is the Israeli Securities Law 1984, with the leading regulatory body being the Israeli Securities Authority.

For security regulations, Israel's regime considers the characteristics of crypto assets to determine if they share similarities with securities. Crypto assets are likely to be classified as security tokens if they offer participatory, ownership, or profits entitlement rights. Additionally, they will be defined as securities if intended for trading on secondary markets. Regulation for securities includes regulation in their offer and sale, especially to the public.

Fund managers, investment advisers, and marketers in Israeli crypto assets are required to obtain licenses from the Israeli Securities Authority. License granting considerations include a review of the applicant's experience, risk in the scheme, and potential for money laundering. Licensing examinations are part of the licensing considerations. License holders must keep records and report to the Israeli Securities Authorities. Moreover, individuals are prohibited from offering security tokens traded on foreign exchanges to non-accredited (unsophisticated) investors unless certain conditions are met. Refer to Section 49A of theSecurities Law 1968.

Israel also mandates providers of financial asset services, including custody and lending services, to obtain a license from the Capital Market Authority. Under the Israeli Financial Services Law, virtual currency, i.e., cryptocurrency, is classified as a financial asset. Therefore, dealers in crypto assets may need a financial services license.

Additionally, the Central Bank of Israel has instructed banks to accept cryptocurrency deposits from corporations holding a license from the Capital Markets Authority. Non-bank members of the stock exchange can offer cryptocurrency trading and custody services. The Supreme Court of Israel has ruled that banks are allowed to conduct digital currency transactions. Refer to Bits of Gold V Gov of the Bank of Israel 7364/22.

Israel requires institutional investors to keep their crypto assets with custodians. The Israeli Securities Authority also oversees payment services under the Israeli Payment Services Law 2019. Crypto-dealing entities providing payment services and facilities are consequently regulated.

Israel has not yet enforced licensing for foreign Crypto exchanges, and no law prohibits Israeli citizens from using foreign exchanges. Foreign cryptocurrency trading companies remain accessible in Israel, unlike in Canada, where the websites of unregistered CTPs are banned, and steep penalties imposed.

It is worth noting that Decentralized Autonomous Organizations ("DAOs") are not recognized as legal entities in Israel, even though they are similar to a digital company.

Canadian Securities Regulation of Crypto

CTPs - Cryptocurrency Trading Companies ("crypto exchanges") providing services to Canadians must register. It is irrelevant whether the CTP is located within or outside Canada. Unregistered CTPs in Canada should file undertakings and comply with specific conditions addressing investor protection pending full registration. Registration requirements protect investors through risk management, disclosure, and good faith obligations.

There are no exhaustive circumstances where security laws apply. They are treated on a case-by-case basis. As per Canadian Securities Administrators (CSA) and Canadian Investment Regulatory Organization (CIRO) regulations, security laws apply to crypto assets if they have the nature of a security or a derivative and are traded on a crypto asset trading platform (CTP).

Security laws will also apply where security tokens are traded to the public. CTPs trading in security tokens, their derivatives, and contracts must register with CIRO as members and investment dealers. Furthermore, custodian services in crypto are subject to regulation. A CTP offering a wallet or similar service where user crypto is stored is subject to securities legislation.

Banks in Canada do not carry out crypto transactions nor accept crypto deposits like Israeli counterparts. However, some banks and financial institutions offer 'crypto for cash' exchange and ATM services, independently run by organizations unassociated with the bank or financial institutions.

As in Israel, DAOs are not Legal Persons in Canada

Israel offers a friendlier crypto environment for foreigners compared to Canada.

From tax and securities perspectives, Israel appears as a more favorable regime for foreigners and crypto activity.

Israel's 10-year tax exemption for new and returning residents and the higher allowance threshold for reporting foreign assets (equivalent of $750,000 CAD) promote foreign investments and ownership of foreign assets in Israel, unlike Canada. This includes crypto assets.

The Canadian regime lacks such exemptions for new and returning residents, offering a $100,000 CAD allowance limit for asset reporting. Many crypto owners hold crypto as an investment, not involved in foreign crypto businesses. Therefore, Israel's allowance limit for foreign asset reporting appeals more to such crypto owners and is broader than the Canadian active business exemption.

In terms of securities, Israel has a more open regime to digital currency than Canada. In a globally-oriented market like crypto, the Canadian government is exclusionary in requiring all foreign CTPs to register with Canada to access Canadians.

This is unlike the Israeli regime, which allows foreign CTPs, offers no prohibition for Israeli citizens trading on foreign CTPs to exchange their crypto, and permits the marketing of foreign crypto securities as long as necessary conditions protect non-accredited (unsophisticated) investors are fulfilled. Furthermore, Israeli banks accept crypto deposits and conduct crypto transactions by law, contrary to Canadian Banks.

Finally, Israel's initiative to exempt foreigners from crypto tax shows the Israeli government's openness to digital currencies. However, the Israeli Iron Swords War seems to sway public sentiments towards avoiding tax increases for the general public. Consequently, secluded asset types like crypto are likely to become easy targets for increased taxes. Hopefully, this will be a temporary situation.

PRO TAX TIPS: Factors the Court Takes into Consideration in Determining if a Crypto Transaction is a Capital or Business Activity

In Canada, to determine whether crypto asset income should be classified as capital or business, the court takes a holistic view of several factors: the nature of the asset, frequency of disposal, length of ownership, motivation at acquisition, effort on the asset, and circumstances at disposal.

The court is more likely to classify income as capital if: it is generally considered a capital property, held long-term, little marketing effort exists, and unexpected sale reasons arise, with the taxpayer's original intention to earn capital income. The opposite of these conditions likely indicates business income.

In Israel, similar considerations exist: property's quality, frequency of disposition, holding duration, ripening and improvement of the property, and special disposition circumstances. These align closely with their Canadian counterparts.

Nevertheless, Israel has additional considerations: volume of disposition, presence of an office, transaction financing, and expertise in the area. More disposition quantity, a permanent office, transaction financing, and proficiency in the field indicate business income.

All the above classification considerations in Israel and Canada can interchangeably apply in both jurisdictions. This is because neither jurisdiction's jurisprudent case factors are exhaustive. If you need help navigating inter-jurisdictional tax practice, our top Canadian tax lawyers can assist you.

Frequently Asked Questions (FAQs)

What are Crypto Assets?

Crypto assets are digital value representations whose transactions are verified and secured by cryptographically managed ledgers or similar technology, often called blockchains. Crypto assets include cryptocurrencies, non-fungible tokens, and security and utility tokens.

What are the classifications of crypto assets and their definitions?

It is nearly impossible to comprehensively account for all crypto asset variations. However, attempts have been made to categorize them. Crypto assets are commonly divided into these categories:

• Cryptocurrencies: These are crypto assets used similarly to currency, as a payment means. They include bitcoins, altcoins, dash, Ethereum, and TAO.

Stable coins are value-referenced coins deriving their value from fiat currency, business pursuits, or other crypto assets, providing value stability:

• Utility tokens: These are crypto assets that grant users the right to use a service or product.
• Security tokens: These are tokens used like securities such as debts, shares, among others. They confer ownership, membership, or other security entitlements rights.
• Non-fungible tokens (NFTs): These are digital ownership representations of an asset or authenticity of the asset or rights within the asset. Such an asset could be virtual or physical. Each token represents a unique asset or right in the asset. NFTs utilize blockchain or similar technology.

Are all Crypto Assets taxed similarly?

Both in Israel and Canada, crypto assets are taxed based on their features. The way or taxes due to a crypto asset depend on its characteristics. This will also determine the timing for the crypto asset taxation.

Disclaimer: This article offers broad information only accurate at posting time. It has not been updated and may be outmoded. It does not provide legal advice and should not be relied upon. Every tax scenario is unique and will differ from those described in the article. If you have specific legal questions, you should seek the advice of an Irs Crypto Reporting Miami tax lawyer.